JD.com will be a $250 Billion Company
JD.com operates a giant online business in China. Contrary to popular belief, it is the most “Amazon-like” of the Chinese retailers, even though Alibaba is the larger and more well-known name in America. JD released earnings this past week and crushed it on a bunch of metrics, which led to the stock shooting up over 10% on the news.
Investors have grown sour on JD for a few reasons, including the rape charges against the CEO (which are serious but likely won’t affect the business), headwinds on the macro-level, and supposed competition from Alibaba.
The stock has rallied into the ’30s with the recent news but is still down big from its all-time high in 2018:
Now, just to be clear, you should never invest in a stock solely because the price has fallen. However, if you objectively still like the business, then a 30% discount can be a great time to buy shares. I think even with the recent price jump we are still in that zone with JD.com.
I’m going to go through a few reasons why I love JD.com’s business and financial trajectory and why it is poised to become a $250 billion company.
Sustainable Revenue and User Growth
Last quarter, revenue for JD was up 23% to $21.9 billion (in U.S. dollars). That is an acceleration from previous quarters with (speculative) negative impacts from a Chinese economic slowdown and trade-war fears baked in. As you can see from this chart provided in the earnings presentation, JD has been able to sustain high sales growth for many years:
They also showed solid user growth numbers in the second quarter, up to 321 million from 310.5 in the same period last year. JD is focused on getting access to “lower-tier cities,” which is what they call rural areas, in order to expand their customer base and total addressable market. It also looks like they are nowhere near customer saturation since China has over a billion people who will all be online within the next decade.
Steady Margin Expansion
Here are two charts chronically JD’s growth in gross and operating margin over time:
Yes, I know these are non-GAAP numbers, but I am lazy and this is what they provided in the earnings presentation.
JD has gone from essentially a break-even business to one with real margins in the past few years, driven mostly by the economies of scale in the retail space. Management also sees this expansion continuing for the foreseeable future. They stated on the conference call that they “should be generating somewhere in high single-digit in combined net margin for the business” at full scale. That would be a big jump from current levels, but one JD can make with their intense level of investment in automation and efficiency.
The Core Business has Better Margins Than you Think
Investors might be deterred from JD’s minuscule operating margins. However, in this quarter alone the core retail business brought in over $1 billion in operating income (OI) at a 2.7% margin. Annualized, that is over $4 billion in OI from a stock with a $45.5 billion market cap.
The “Other Business” segment that includes technology and logistics had a $300 million operating loss this quarter that hurt the total operating margin significantly.
Great Cash Flow Numbers
In this quarter alone JD produced $2.6 billion in free cash flow, and that is with them still investing heavily into their logistics and technology segments. This wasn’t a one-time spike either. Last year they produced $2 billion of FCF in the second quarter with a negative Capex impact of almost $1 billion.
Any way you spin it, JD has turned into a cash flow machine, which will enable them to reinvest into the business without having to dilute shareholders or bring on more debt.
Developing a Moat
A lot of people see Alibaba as a threat to JD.com, but I see them as the only other player in a duopolistic Chinese online retail system. Tencent (who doesn’t do much retail at all) and Wal-Mart are both invested in JD, so competition from them seems unlikely. Amazon has also struggled mightily in China.
It will be tough for any startup to come in and take market share. People use JD.com because it offers same or one-day delivery to almost all of China with millions of different products on the site. An upstart cannot just replicate that out of the blue. It took JD billions upon billions of R&D and Capex to develop this network of highly efficient fulfillment centers. JD 100% has a strong moat; one that will only widen as they scale.
Side Businesses that Make Sense
Besides a small investment arm, JD’s “Other” segment is mainly just its logistic/delivery initiatives. It is basically their version of Amazon fulfillment and Amazon shipping that will allow them to move into another part of the eCommerce vertical.
As well, all of JD’s technology investments are in the retail/delivery space. They rarely stray from their area of core competency, something I like about the company. Sure, there’s no doubt JD could have added a cloud or consumer payments app like Alibaba to accelerate sales growth in the short-term. But I believe not stretching themselves too thin across different parts of the economy will pay-off in the long-run. They can focus on increasing their lead as the most efficient and technologically driven retail business on the planet.
Why JD.com Can be a $250 billion Company
I think there’s a good chance JD.com dethrones Baidu and becomes the third tech giant in China. The thesis is simple: sales growth and margin expansion will continue, leading to major growth in profitability over the next decade.
Remember that, in the conference call, JD executives reiterated their long-term goal of high single-digit net margins. Let’s say that ends up being around 7.5%. Let’s also assume JD can sustain a 12% sales growth rate over the next 10 years (a slow-down from current levels, with the law of large numbers coming into play). With those two assumptions in mind, here is a chart tracking what JD’s net income would be from 2019 to the end of 2028.YearSales ($ billions)Net MarginNet Income ($ billions)201975.260.5%0.3763202084.31.0%0.843202194.411.5%1.422022105.742.0%2.112023118.432.5%2.962024132.643.0%3.982025148.564.0%5.942026166.385.0%8.322027186.356.0%11.182028208.717.5%15.65
Obviously, growth will not be this precise or consistent over a ten year period. However, if JD grows sales at 12% over the next decade (a low-ball number if you ask me) and increases its net margin to 7.5% as it claims it can, it will be generating $15.65 billion in net income in 2029. Give it a conservative P/E ratio of 18 (fairly average for a mature but not stagnating stock) and JD’s market cap would $281.7 billion. Today, it has a market cap of $45.5 billion.
Now, as with any investment, there’s no guarantee JD will continue its strong sales growth or be able to reach high single-digit net margins. However, I think there is a strong chance they do, especially because of their Amazon-like investments in automation and logistics.
Disclosure: The author is not a financial adviser, and may have an interest in the companies talked about.